Market has continued to trend higher with Europe staying around the middle of the range we had since the beginning of April. Daily volatility is quickly dropping along with equity volumes. The world’s largest and most liquid index, the S&P 500, currently trades on ~20.3x forward earnings or 3.2x book value, both of which are at the high end of the 20-year range. With the US economy suffering one of its worst downturns in history, the disconnect between valuations and fundamentals is impressive. The Nasdaq has erased all Ytd losses but the resilience of the Nasdaq is masking the pain that has been taken elsewhere with the median stock in US and Europe still ~30% below its 52-week high.

In such an illiquid market, any reason could be good to move it/up intraday. Yesterday we had some Phase one trade optimism back on the headlines. Top Chinese and US trade negotiators will speak next week on progress in implementing a phase-one deal.

The reality is that the “pain trade” is still up as most investors are still underweight and while negative news are quickly absorbed, any mildly positive news/data has a much larger effect.

Have a look at the Merrill’s Bull & Bear current indicator still in extremely bearish phase.

And at the chart showing the beta of the largest holdings at Merrill high net-worth private banking clients which clearly show the defensive nature of the equity participation right now.

Today the UK & Denmark are closed for bank holiday

We talked a lot about narrowing market breadth and Tech/Growth leadership in US, but check the incredible divergence of the return distribution for S&P500. In the chart below, we show that the most heavy-weight US market cap, merely FAANG + Microsoft, have massively outperformed the market by more than 20%, while the total average return of remaining 495 S&P500 companies lost 13% year-to-date.

Oil prices were on fire yesterday, after Saudi Arabia is indicating it sees demand beginning to recover in its largest regional market.

Aramco raised its official June selling price for flagship Arab Light crude to buyers in Asia by $1.40 a barrel, to a discount of $5.90 below the Middle East benchmark (from a massive discount to history to a large discount to history). The company was expected to reduce its official pricing by $2.50 a barrel, to a discount of $9.80. The price increase may suggest Saudis will not just cut their production as part of the OPEC+ deal, but also reduce their crude exports by making them more expensive.

ICE gasoil crack slipped to $5.62/bbl on Thursday, and headed for its weakest close since at least 2011.

WTI June-July spread’s contango narrowed to as little as -$1.05 on Thursday, the strongest level for the specific spread since early April.

WTI June-July spread

Saudi Aramco raised crude pricing for most grades to Asia, giving a clear indication there are signs demand is improving as the biggest oil-consuming market starts to recover from coronavirus closures.

Central banks and Government actions

In US, the gross national debt (total of all Treasury securities outstanding) has jumped by 1.05trln$ in 4 weeks since the 7th of April and by 1.54trln$ in the 6 weeks until the 23rd of March to 25.06trln$! The data was released yesterday, we should obviously expect the pace to have continued even over the last few days. The chart is really impressive.

What is even more impressive is that from the 11th of March through its balance sheet released last Thursday, the Fed added $1.39 trillion in Treasury securities to its assets. Over the same period, the Treasury Department added $1.54 trillion to the outstanding debt. In other words, the Fed has indirectly monetized 90% of this additional debt. We’re living off printed money.

Interestingly, the 2-year US Treasury yield slumped to record low, 0.125% while US Fed Fund rate contract for 2021 rose above par (100), a level that marks the boundary to negative interest rates. It means that the market is discounting negative Fed Fund rate next year.

Fed Fund future 2021

There have been talks over the last couple of days about a US capital gain tax cut. President Trump and his advisers are weighing a range of business and investor tax cuts for the next coronavirus aid package, including a reduction in the capital gains rates.  Ideas also include measures that would allow companies to deduct the full costs of investments made now or in the future

In Europe the mood is definitely less dovish as while the Governing Council hasn’t decided on a plan to respond to Tuesday’s ruling, which declared the ECB’s biggest bond-buying program potentially unconstitutional, members seem to be split on who takes the lead. Some see the issue as a domestic matter to be mainly resolved between the Bundesbank and the German government.

Yesterday, the Bank of England kept rates on hold and total bond purchases unchanged. 2 officials voted for immediately increasing Quantitative Easing by £100 billion ($124 billion) versus 7 officials against. The current QE target, £645 billion, will be hit by July, with Bailey saying more stimulus may be coming in June. Overall less dovish than expectations.

Bank of England said the economy could shrink 14% in 2020, before rebounding in 2021. Most of the hit to come in Q2, with GDP down 30% YoY, consumer spending to be down 30%, housing market activity practically ceased, companies’ sales down 45%,  business investment having halved and unemployment rate more than doubling to 9%. Also assumed U.K. economy recovers all its lost growth by late 2021 and inflation back at target 2% in 2022 (too much optimistic in our view).

In the following two charts, we show that current BOE’s balance sheet is hovering around $700 billion, or 32% of GDP, and BOE’ weekly purchases are large compared to other central banks such as ECB or FED.

The Central bank of Norway unexpectedly cut its main benchmark rate to 0 from 25bps, forecasting the worst economic contraction since 1940. Take into consideration that Norway has always been skeptical of zero-bound, negative rates. Current forecast 2020 GDP down 5.2%, before rebounding 3% in 2021. In addition, Norway is making record withdrawals from its $1 trillion wealth fund, the first time in its history to provide the cash the government needs.

Q1 Earnings

As of today, 2/3 of US and European companies have reported Q1 numbers while in Japan we are still at 23%.

Earnings are continuing to surprise to the downside vs consensus estimates in all regions but market is not too surprised about these data in terms of market reaction at aggregate level. As we have already explained in the past, expectations for Q1 were lowered on the S&P by ~9% through the last few weeks.

In US, the number of companies beating EPS estimates is currently at 10-year lows. In Europe the EPS growth is down 23% YoY and sales down 6% YoY (chart below).

Interestingly, maintaining investments in Technology (54%) and investments to drive organic growth (44%) were the two most commonly cited top priorities by the CFOs and COOs.

The short term environment is challenging and management teams short-term priorities seems to be enhancing financial defense/reduce spending and maintaining liquidity.

It is likely that they will decide to scale back investment spending being careful of not losing competitiveness. One of the point is likely to be further employment reductions ahead with further softness for the labor market ahead.

Distressed US companies & Emerging Markets

According to Bank of America, there has been a surge in defaulted and deeply distressed US companies. It is not surprising that $17 billion has defaulted in April, while another $27 billion in issuers now on the bank’s default watchlist (on the brink of bankruptcy) among which Hertz, Intelsat, JC Penney, Neiman Marcus, and finally $25 billion in deep distress, whose bonds are currently trading below 50 cents and have experienced price plunge by 50% from their maximum price within last 6 months. It’s also very interesting to see the positive correlation between the US commercial bank loan delinquency rate versus the US unemployment rate which is skyrocketing. In the chart below, we show that loan delinquency rate is set to catch up pretty soon.

US Loan Delinquency rate (red) vs US Unemployment rate (blue)

Another worrisome point is given by the strong relationship between the US total new Chapter 11 bankruptcy fillings versus US unemployment rate (which it makes sense, both are consequential). Here the problem is moving from liquidity to solvency.

US total new Chapter 11 bankruptcy fillings (red) vs US unemployment rate (blue)

BlackRock CEO Fink was reported yesterday on Bloomberg saying that as bad as things have been for corporate America in recent weeks, they’re likely to get worse.
Mass bankruptcies, empty planes, cautious consumers and an increase in the corporate tax rate to as high as 29% were part of a vision Fink sketched out on a call this week.

He has been advising President Donald Trump on how to navigate the effects of the coronavirus pandemic. And BlackRock is playing a key role in the Federal Reserve’s efforts to stabilize markets, helping the central bank buy billions of dollars in assets.
Fink said on the call with clients of a wealth advisory firm that bankers have told him they expect a cascade of bankruptcies to hit the American economy, and he wondered if the Fed needed to do more to provide support.

Among his predictions he said that US would be lifting the 21% corporate rate signed into law as part of 2017’s tax overhaul to about 28% or 29% next year and he also sees tax rates for individuals going up. Now, at a time when many taxpayers are less able to bear the burden of higher taxes, the government may be forced to extract a larger share of companies’ and individuals’ income.

Among Emerging markets, we are seeing some currencies completely smashed against $ such as Argentina peso (well it’s defaulting again for the 9th time), Russian ruble, and the Turkish lira which recently breached its record low.

The key issue in Turkey is that many analysts and investors are negative because of the actions of the central bank. Debt in Turkey continues to increase at an incredible rate. The country has more than $168 billion of foreign-currency debt coming due over 12 months and relies on external financing to roll these obligations. Central bank keeps slashing interest rates aggressively and burning through borrowed FX reserves. Foreign investors have pulled more than $8 billion out of local-currency bond and equity markets in 2020. The Turkish regulator has banned local banks from trading with global lenders (Citi, UBS etc, failed to meet their lira liabilities) and delivered several regulations in order to further deter short selling, along with intervening on the open market (buy lira, sell $).

So far, the Lira is down 21%, at the lowest level ever touched.

Turkish Lira vs USD currency

Macro

Yesterday we had another day of awful data.

In US, initial claims for unemployment insurance benefits rose to 3.17 million from 3.8 million previous versus 3 million consensus. That brings the total number of claims filed over the last seven weeks to 33.5 million, which is over 12 times the prior worst five-week period in the last 50-plus years.

Continuing jobless claims, at 22.6 million, were also higher than the consensus expectation of 19.8 million. This was the highest number ever recorded. The insured unemployment rate rose to 15.5%, which gets us pretty close to the consensus forecast of 16% unemployment in April.

US Initial jobless claims

According to Challenger job cut announcement, job cuts surged 1576.9% YoY.

In Europe, industrial and manufacturing French and German production slumped to super low levels. A 9.2% decline in output in Germany and a 16.2% drop in France are the latest signs of the severity of Europe’s slump.

Germany industrial production (dark) vs France (light)

Retail sales in Italy smashed at the lowest level ever recorded in March, at -21.3%.

Italian Retail sales chart since 2000